$100 billion meltdown in U.S. subprime mortgage market to have limited impact on Canada, finds CIBC World Markets report
TSX Expected to Outperform S&P 500 TORONTO, April 3 /CNW/ - CIBC (CM: TSX; NYSE) - Rising global energy and base metal prices will outweigh impacts from the woes in the U.S. housing and subprime mortgage market and drive the TSX to outperform the S&P 500 this year, finds CIBC World Markets' latest Canadian Portfolio Strategy Outlook report. "While we expect to see further distress in both the U.S. housing market and the subprime mortgage market, there is little if any evidence of broad contagion effects in financial markets," says Jeff Rubin, Chief Strategist and Chief Economist at CIBC World Markets. "Corporate spreads remain tight by any historic benchmark while option volatility on the S&P 500 is only a fraction of that seen during last year's panic attack over the U.S. Federal Reserve's tightening." The report notes that the TSX, given its resource and energy base, is far more impacted by global growth than it is by either Canadian or North American economic performance. Recent increases in both energy and base metal prices have brightened the outlook for the TSX. "Together with soaring uranium prices and firming natural gas prices, the return of US$70 per barrel oil will catapult the TSX energy sector to new highs," notes Mr. Rubin. "Buoyed by its reliance on global resources and with less exposure to the sub-prime mortgage market, we expect the TSX to outperform the S&P 500 this year." While the TSX is far from immune from any fallout from the subprime mortgage market, the S&P 500 is far more directly exposed, finds the report. It notes that the Canadian financial services industry is far less exposed to the subprime mortgage market than its U.S. counterparts. The subprime market represents less than five per cent of new mortgages in Canada but over 20 per cent in the U.S. Moreover, consumer stocks are similarly more at risk in the U.S. than in Canada from any collateral damage from the housing market. While the report notes that there could still be cross-border spillover effects on the Canadian consumer, such stocks including the domestically oriented media group, account for only 8 per cent of the TSX market cap compared to 20 per cent of the S&P 500. CIBC World Markets also expects that the U.S. Fed will be prepared to cut interest rates to contain any contagion effects outside of the housing industry, particularly to offset any impact on consumer spending. Mr. Rubin believes that the subprime mortgage shock is "unlikely to come even close to the Savings and Loan crisis of the late 1980s or the dot.com bubble collapse. Our projections assume that soaring delinquencies on subprime mortgages will eventually lead to a 30 per cent default rate. We have assumed only a subsequent 50 per cent recovery rate on defaulted loans, allowing for continuing declines in property prices. Even so, losses are unlikely to come in above $100 billion." The Savings and Loan crisis saw losses of $270 billion, with the losses in the Dot-Com collapse reaching $5 trillion, both in today's dollars. The report notes that the TSX has already recuperated much of the ground lost in February's angst over China and initial fears about the U.S. sub-prime mortgage market. The U.S. Federal Reserve's shift back to a neutral bias at its March meeting was enough to lift the TSX Composite back to within striking range of its early 2007 peak. Mr. Rubin expects the TSX will exceed that in the next quarter. He remains 10 percentage-points overweight equities in his portfolio, and believes his TSX year-end target of 14,250 should yield a total return of nearly 13 per cent. Mr. Rubin remains 3.5 percentage points overweight in energy. He cites that rising tensions with Iran, the upcoming Nigerian elections, and early weather warnings of a more active hurricane season in the Gulf of Mexico this year, should see crude prices rise steadily to top US$75 per barrel by the fourth quarter of this year. He expects base metal stocks to set new highs this year on the back of strengthening copper and nickel prices while gold shares look undervalued relative to bullish prospects for bullion. CIBC World Markets also remains overweight financial institutions and particularly banks. The report notes that Canadian banks continue to outpace their U.S. counterparts and are well positioned to benefit from any second-half cuts in North American interest rates. The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/psapr07.pdf. CIBC World Markets is the wholesale and corporate banking arm of CIBC, providing a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.